I believe the tool that would work best for you is a gross rent multiplier (GRM). The reason I say that is because working with a GRM is a lot easier to do than trying to work with an overall rate – aka “cap rate”. In order to even use an overall rate, you have to analyze the income stream down to its net income level, which means coming up with fixed and variable expense ratios.
A GRM only requires you to figure out the market rents for a property, which for a single family residence is hard enough.
At the bottom of the last cycle, GRMs were running as low as 120, meaning the properties were selling for 120 times their monthly rent; or 10x their annual gross. The typical range was about 140-150 or so, depending on the area. Now the bottom of the last cycle represented an extreme low point at which the pricing trends were undervalued relative to the long term trendlines for population, wages and pricing.
At peak, pricing resulted in GRMs topping out in the 350 -370 (!!) ranges for those residential properties that would typically be rented. That’s obviously more than double the low point, and is yet another indication why the relationship between rents/prices will eventually correct.
I think that if you can wait until prices drop to result in a GRM of 175 or below you’ll be a lot closer to what a property will be worth relative to the long term trend that will extend beyond any individual cycle. BTW, the difference between 150 and 175 is substantial: $2,000/month x 150 = $300,000; $2,000/month x 175 = $350,000.
It’ll be interesting to see if rents contract at the same time prices are correcting. So far they haven’t.
